Rick Harbaugh

Comparative Cheap Talk

When are comparative statements credible? For instance, when can a professor rank different students for an employer, or a stock analyst rank different stocks for a client? We show that simple complementarity conditions ensure that an expert with private information about multiple issues can credibly rank the issues for a decision maker. By restricting the expert’s ability to exaggerate, multidimensional cheap talk of this form permits communication when it would not be credible in a single dimension. The communication gains can be substantial with even a couple of issues, and the complete ranking is asymptotically equivalent to full revelation as the number of issues becomes large. Nevertheless, partial rankings are sometimes more credible and/or more profitable for the expert than the complete ranking. We confirm the robustness of comparative cheap talk to asymmetries that are not too large. Moreover, we show that for a sufficiently large number of independent issues there are always some issues sufficiently symmetric to permit influential cheap talk.

Label Confusion: The Groucho Effect of Uncertain Standards

Labels certify that a product meets some standard for quality, but often consumers are unsure of the exact standard that the label represents. Focusing on the case of ecolabels for environmental quality, we show how even small amounts of uncertainty can create consumer confusion that reduces or eliminates the value to firms of adopting voluntary labels. First, consumers are most suspicious of a label when a product with a bad reputation has it, so labels are often unpersuasive at showing that a seemingly bad product is actually good. Second, label proliferation aggravates the effect of uncertainty, causing the informativeness of labels to decrease rather than increase. Third, uncertainty makes labeling and nonlabeling equilibria more likely to coexist as the number of labels increases, so consumers face greater strategic uncertainty over how to interpret the presence or absence of a label. Finally, a label can be legitimitized or spoiled for other products when a product with a good or bad reputation displays it, so firms may adopt labels strategically to manipulate such information spillovers, which further exacerbates label confusion. Managers can reduce label confusion by supporting mandatory labeling or by undertaking investments to make certain labels “focal.” This paper was accepted by Pradeep Chintagunta and Preyas Desai, special issue editors. This paper was accepted by Pradeep Chintagunta and Preyas Desai, special issue editors.

Does Copyright Enforcement Encourage Piracy

When copyright enforcement is targeted at high-value buyers such as corporate and government users, the copyright holder charges super-monopoly prices, thereby encouraging low-value buyers to switch to inferior pirated copies. We show that enlarging the copyright holders captive market through more extensive copyright enforcement reduces prices toward the monopoly level, increases sales of legitimate copies and can increase consumer surplus. Therefore, in contrast with the case of more intensive copyright enforcement, more extensive copyright enforcement over some range can increase the incentive to generate intellectual property while also reducing the loss to consumers from monopoly power.

Prospect Theory or Skill Signaling

Failure is embarrassing. In gambles involving both skill and chance, we show that a strategic desire to avoid appearing unskilled generates behavioral anomalies that are typically explained by prospect theory’s concepts of loss aversion, probability weighting, and framing effects. Loss aversion arises because losing any gamble, even a friendly bet with little or no money at stake, reflects poorly on the decision maker’s skill. Probability weighting emerges because winning a gamble with a low probability of success is a strong signal of skill, while losing a gamble with a high probability of success is a strong signal of incompetence. Framing matters when there are multiple equilibria and the framing of a gamble affects beliefs, e.g., when someone takes a “dare” rather than admit a lack of skill. The analysis is based on models from the career concerns literature and is closely related to early social psychology models of risk taking. The results provide an alternative perspective on the existence of prospect theory behavior in economic, financial, and managerial decisions where both skill and chance are important. We identify specific situations where skill signaling makes opposite predictions than prospect theory, allowing for tests between the strategic and behavioral approaches to understanding risk.

Persuasive Puffery

Sellers often make claims about product strengths without providing evidence. Even though such claims are mere puffery, we show that they can be credible because talking up any one strength comes at the implicit trade-off of not talking up another potential strength. Puffery pulls in some buyers who value product attributes that are talked up or emphasized while pushing away other buyers who infer that the attributes they value are relative weaknesses. When the initial probability of making a sale is low, there are more potential buyers to pull in than to push away, so puffery is persuasive overall. This persuasiveness requires that buyers have some privacy about their preferences so that the seller does not completely pander to them. More generally, the results show how comparative cheap talk by an expert to a decision maker can be credible and persuasive in standard discrete choice models used throughout marketing, economics, and other disciplines.

Equity Stakes and Hold-up Problems

Equity ties between businesses change the division of the firms’ joint profits, thereby affecting incentives for relation-specific investments and other strategic actions. Depending on which side owns the equity and how readily the equity can be resold, we find that the changed incentives can resolve all four types of holdup-related problems: underinvestment, overinvestment, undercooperation, and sabotage. Equity stakes indirectly affect bargaining over the joint profits by making the bargaining positions of the firms dependent on each other. For instance, if one firm is made unprofitable by a breakdown in negotiations, the other firm loses as well. Since bargaining positions are linked, each firm benefits less from attempts to grab a larger share of the joint profits by strengthening its relative bargaining position, and benefits more from actions that increase joint profits. While both firms can gain from increased efficiency due to the equity stake, firms in many cases should only acquire an equity stake if they can bargain for a discounted price.

Ordinal Cheap Talk in Common Value Auctions

Sellers benefit on average from revealing information about their goods to buyers, but the incentive to exaggerate undermines the credibility of seller statements. When multiple goods are being auctioned, we show that ordinal cheap talk, which reveals a complete or partial ordering of the different goods by value, can be credible. Ordinal statements are not susceptible to exaggeration because they simultaneously reveal favorable information about some goods and unfavorable information about other goods. Any informative ordering increases revenues in accordance with the linkage principle, and the complete ordering is asymptotically revenue-equivalent to full revelation as the number of goods becomes large. These results provide a new explanation in addition to bundling, versioning, and complementarities for how a seller benefits from the sale of multiple goods.

Biased Recommendations from Biased and Unbiased Experts

Can experts be trusted to provide useful recommendations? We develop and experimentally test a simplified recommendation game where an expert recommends one of two actions to a decision maker who might instead take no action. Consistent with predictions from the cheap talk literature, we find that recommendations are persuasive in that they induce actions benefiting the expert, but decision makers partially discount recommendations for the action a biased expert favors. Even unbiased experts pander by recommending the action that the decision maker already favors, which decision makers then discount. And if the decision maker is uncertain over whether the expert is biased or not toward an action, unbiased experts follow a political correctness strategy of recommending the opposite action to be more persuasive. However, decision makers do not sufficiently anticipate how uncertainty over the experts bias gives even unbiased experts an incentive to lie, implying that transparency may be even more important to successful communication in practice than it is in theory.